If you've been following Green Check for any length of time, you know that we advocate regularly for banking the cannabis industry in a compliant manner. More and more lately we've been asked about whether or not an institution can, or should, lend to these businesses as well as provide them deposit services.
The answer is yes, you can.
Like with offering deposit products to cannabis businesses, you have some work to be done to make the line of business compliant with BSA/AML guidelines. But the good news is that if you already have a deposit program, you're more than half way there.
Here's what you need to consider.
- Initial and Ongoing Due Diligence - Any cannabis business that you work with, on either side of the house, has to be a legal business under your state's cannabis laws. That means you have to collect documentation verifying that as part of the application (if you don't already have it on the deposit side). Some of the documentation will be documentation you're already collecting and familiar with, like financials and tax returns. And, like other commercial loans, you'll need to review this documentation regularly as part of your ongoing review and risk rating process. What will be new to the commercial team is the concept of filing quarterly SAR reports and monitoring transaction activity. My recommendation though would be to partner with the Compliance team for these pieces as this is their area of expertise, and they'll have a policy and procedures in place for handling this type of businesses already.
- Collateral - This is the one that pauses most lenders. Because of the line of work these businesses are in, you cannot attach or repossess inventory, real estate, or equipment directly involved in cannabis business. Well, you could, but it would be tricky to protect your lien, particularly if you are up against Federal law enforcement seizing assets for illicit activity. And even if you did protect your lien, you wouldn't be able to take possession after default due to the fact that you as the Financial Institution are not licensed to be in possession of a controlled substance. But here's what you can do. You can collateralize the loan with assets unrelated to the cannabis business, ask for personal guarantees, and over collateralize when possible.
- Bankruptcy - Cannabis businesses are not allowed to seek bankruptcy protection per the Office of the US Trustees. This means there is no orderly distribution process of assets should a cannabis business go out of business. For this reason, you may want to discuss adding Receivership language to your loan agreement with legal counsel.
- Pricing - Because of the extra risk involved, you have the ability to price these loans above the rate you would expect to get from other borrowers, typically, 50 to 100 bps.
- Reserves - If you're being prudent, and should you need to discuss mitigating controls to this higher risk line of business with an examiner, you'll want to put aside some padding in your loan loss reserve.
- Concentration Limits - Your credit policy should have concentration limits for this segment of the portfolio, and I would recommend that they be at or below other risky lines of business. For example, if you have a limit of 40% of your portfolio for commercial construction lending, you may want to set the cannabis portfolio at 25%-30%. Monitor this limit religiously so that you don't ever have to explain why you've exceeded it. And take a look at your loans-to-one-borrower policies as well. Many of the folks who are part owners in cannabis businesses are also involved in other local endeavors and may already be on your books.
So yes, there is some higher risk here, but it can be done with good policies, procedures and monitoring. And it'll give you the opportunity to diversify the portfolio into an industry that does not seem to be as impacted by the current down turn, and give your net interest margin a boost.